THE MOTION PICTURE INDUSTRY CRITICAL ISSUES IN …

[Pages:55]THE MOTION PICTURE INDUSTRY: CRITICAL ISSUES IN PRACTICE, CURRENT RESEARCH & NEW RESEARCH DIRECTIONS

Jehoshua Eliashberg

Sebastian S. Kresge Professor of Marketing & Professor of Operations and Information Management

The Wharton School University of Pennsylvania

Philadelphia, U.S.A +1 610 649 1926

eliashberg@wharton.upenn.edu

Anita Elberse

Assistant Professor Harvard Business School

Harvard University Boston, U.S.A +1 617 495 6080

aelberse@hbs.edu

Mark A.A.M. Leenders

Assistant Professor The Amsterdam School of Communications Research University of Amsterdam Amsterdam, the Netherlands

+31 20 525 6689 m.a.a.m.leenders@uva.nl

Acknowledgements: The authors thank Peter Davis, Liran Einav, Ron Goettler, Chuck Moul, Barak Orbach, Martin Peitz, Olav Sorenson, the reviewers, the Associate Editor, and the Editor for helpful comments and suggestions. Jehoshua Eliashberg acknowledges the support provided by the Fishman-Davidson Center for Service and Operations Management at the Wharton School; Anita Elberse acknowledges the support provided by the Division of Research at Harvard Business School; Mark Leenders acknowledges the support of the Erasmus Research Institute of Management.

First Draft: May 29, 2004 This Draft: February 23, 2005

THE MOTION PICTURE INDUSTRY: CRITICAL ISSUES IN PRACTICE, CURRENT RESEARCH & NEW RESEARCH DIRECTIONS

ABSTRACT

The motion picture industry provides a fruitful research domain for scholars in marketing and other disciplines. The industry has a high economic importance and is appealing to researchers because it offers both rich data that cover the entire product lifecycle for a large number of new products and because it provides many unsolved 'puzzles'. Despite the fact that the amount of scholarly research in this area is rapidly growing, its impact on practice has not been as significant as in other industries (e.g., consumer packaged goods). In this article, we discuss critical practical issues for the motion picture industry, review existing knowledge on those issues, and outline promising research directions. Our review is organized around the three key stages in the value chain for theatrical motion pictures: production, distribution, and exhibition. We discuss various conjectures, framed as research challenges or specific research hypotheses, related to each stage in the value chain, followed by a set of specific research avenues for each of those stages. We focus on what we believe are critical managerial issues.

Keywords: Motion Picture Industry, Entertainment Industry, Review, Research and Models

INTRODUCTION

Over the last two decades, the amount of academic research on issues related to the motion picture industry has risen sharply. This growth might have a number of reasons. First, the industry has a high economic importance in the global economy. The motion picture industry employs over half a million people in the U.S. (U.S Department of Labor 2004). Spending on theatrical tickets was around $9 billion in the U.S. and close to $11 billion internationally in 2004 alone; revenues from ancillary markets (particularly home video, but also merchandising) are several times higher (Standard & Poor's 2004). Motion pictures are a key driver of the market for entertainment products ? currently the number one export market for the U.S. Second, the availability of rich data makes the industry particularly appealing from a research perspective. For example, many new, unique products are released in a relatively short time period. The 'cradle-tograve' scope, with data covering the entire product life cycle, provides ideal conditions for marketing researchers. Third, industry practitioners rely heavily on tradition, conventional wisdom, and simple rules of thumb, which often have not ? but should ? be closely examined. Intriguing puzzles still exist, such as the extent to which traditional contracts among channel partners or uniform ticket pricing policies are optimal. Fourth, insights from the motion picture industry may help to better understand industries that share certain characteristics as well as to examine the interface between technology and experience goods in the digital age (Schmitt 1999; Wolf 1999).

In this article, we set out to review the rapidly growing body of research on the motion picture industry. We do so for two main reasons. First and foremost, we believe that a reassessment of research directions is needed particularly at this point because many critical issues for practice remain unaddressed. Our goal here is to share insights into the motion picture industry in such a way that they will stimulate managerially relevant research. Second, because we are convinced that a greater focus on industry-specific research can benefit the marketing discipline, we hope that our review will serve as an example of an approach to the development of a research agenda, and as such will stimulate similar efforts for other industries.

We focus our attention on the theatrical motion picture industry, and divide the manuscript into three sections ? production, distribution, and exhibition ? that correspond to the three key stages

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in the value chain for theatrical motion pictures that precede their 'consumption' by movie-going audiences (see Figure 1).

Figure 1: The Value Chain of Theatrical Motion Pictures

Production

Distribution

Exhibition

Consumption

Different types of entities and individuals participate in each stage of the value chain. The competitive landscape includes vertically integrated major studios, independent production companies, independent distributors, major national exhibition chains as well as smaller regional exhibitors and art houses. Studios are often simultaneously engaged in four distinct functions: financing, producing, distributing, and advertising (Squire 2004, Vogel, 2001). Here, we consider the first two functions together under the heading 'Production'. It can be defined as the activities needed to produce one copy (or, in industry terms, one 'print') of the movie. The latter two functions are discussed under the heading 'Distribution'. In essence, these functions encompass all of the distributor's interactions with its two main groups of customers ? exhibitors and audiences. 'Exhibition' refers to activities performed by theater chains and individual theater sites.

We recognize that the motion picture industry encompasses a number of subsequent revenue windows ? including domestic theatrical, foreign theatrical, home video, pay television, network television, syndication, video games and merchandising. Although a comprehensive review of non-theatrical windows is beyond the scope of our study, we venture into these areas as far as they are relevant to the behavior of players involved in the theatrical arena.

The three sections are structured in a similar way. We begin each with a description of the general process and current status of research. Next, we describe key practical issues that in our opinion are worthy of research. We do not intend for our descriptions of practical issues to be exhaustive ? instead, we set out to highlight what we, based on our knowledge of the industry, interactions

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with industry executives and observers, and review of trade publications, view as critical issues, for each stage of the value chain. We propose various conjectures ? inferences based on inconclusive or incomplete evidence ? and research challenges. We acknowledge that the conjectures are often speculative. Our aim is to examine the extent to which critical issues have already been studied ? and if so, what key findings emerge ? and to what extent they have not. Our review shows that the range of methodologies employed in existing research is already quite broad, and includes regression-based econometric techniques, discrete-choice models, and operations research methods. However, our focus is not on the methodologies employed.

Closely related to our theme, but not reviewed in this paper because of the availability of other reviews (e.g., Litman and Ahn 1998), is the extant literature that deals with consumers and their movie-going behavior. Ever since 1914, in what must have been one of the earliest studies on the drivers of the behavior of movie audiences, DeMaday (1929) asked Swiss school children 'why do you like going to the cinema?' (Palmgreen, Cook, Harvill, & Helm, 1988), researchers have attempted to understand what drives movie consumption. Jowett (1985) provides an informative review of movie audience research in the first half of the 20th century. He observed that "no major American industry ever operated with so little research of its market as did the motion picture industry during the period of its greatest influence, from its early years until the mid1950s". It was not until the 1940s that the industry began to move beyond anecdotal studies to more systematic research methods, mostly regularly administered surveys. In that period, academic researchers such as Lazersfeld (1947) laid the groundwork for further research on movie audiences, in areas such as psychology, sociology, communications, and film studies (see Blowers 1991). More recently, conceivably partly in response to Hollywood's increased focus on 'the bottom line', interest in the motion picture industry has spread to other fields ? particularly industrial organization, economics, strategy, and marketing.

An understanding of audience behavior is fundamental to shedding more light on the challenges faced by producers, distributors, and exhibitors. For instance, it plays a critical role in forecasting movies' financial performance and assessing the impact of new technologies. The literature has been divided into two research traditions: the 'psychological approach' and the 'economic approach'. The 'psychological approach' focuses on individual decisions to first attend movies from among the vast array of entertainment options and second, and more critically, to choose particular movies (e.g. Litman & Ahn, 1998). Researchers adopting this approach aim to relate such variables as opinions, needs, values, attitudes and personality traits to consumers' decision-

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making processes. Such studies generally use data collected by surveying individual consumers. Examples are Austin (1986; 1989), Becker et al (1985), Cuadrado and Frasquet (1999), D'Astous and Touil (1999), De Silva (1998), Moller and Karppinen (1983), Palmgreen et al (1988), and Palmgreen and Lawrence (1991). Another relevant stream of research within the psychological approach has focused on the role of mood as an antecedent of individual consumption-related outcome. See for example Eliashberg and Sawhney (1994) for an application to movie watching.

Studies within the 'economic approach' explore factors that influence collective movie attendance decisions. The economic approach seeks to explore the variables that influence the financial performance of motion pictures. These studies typically use aggregate data on movie-going behavior collected by industry trade sources. Examples of such studies include Litman (1983), Litman and Kohl (1989), Litman and Ahn (1998), De Vany & Walls (2000), Dodds and Holbrook (1988), Elberse & Eliashberg (2003), Eliashberg and Shugan (1997), Hennig-Thurau, Walsh and Wruck (2001), Jedidi, Krider and Weinberg (1998), Moul (2004), Prag and Casavant (1994), Ravid (1999), Simonoff and Sparrow (2000), Smith and Smith (1986), Sochay (1994), Wallace et al (1993), and Zufryden (1996; 2000). Effectively bridging both approaches, some studies model aggregate patterns of motion picture diffusion based on assumptions about underlying adoption processes on an individual level (e.g. De Vany & Walls 1996; Neelamegham and Chintagunta 1999, Sawhney & Eliashberg, 1996).

PRODUCTION

The development of a motion picture is a long succession of creative decisions with far-reaching economic implications for the different players involved. Each movie's development process is unique, but some general observations can be made. The process commonly begins with a story concept based on a literary property, a new idea or a true event (Vogel, 2001, Squire 2004), which can vary from a general idea (a 'pitch') to a completed screenplay (a 'spec'). In some cases, a studio or producer will ask a writer to develop a new (or adapt an existing) screenplay. Usually, however, with help from a literary agent, a writer submits a first draft of a screenplay for review to a number of independent and/or studio affiliated producers. If a producer is interested ? many screenplays never pass this hurdle ? both parties usually sign an option agreement, which gives the producer the right to purchase the complete screenplay, and the writer an advance payment (of which the literary agent takes a percentage).

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At this point, substantial financing is required to take the project into production. Financing is less problematic if the producer is affiliated with a studio (an example is the deal that Ron Howard and Brian Grazer's Imagine Entertainment has made with Universal Studios). By signing a studio contract a producer usually gives up a wide range of rights relating to sequels, spin-offs, merchandising, and other opportunities, but at the same time increases his chances of securing bank loans or tapping into the studio's own capital, and securing favorable distribution and exhibition deals for completed movies. Such contracts are beneficial from the studio's perspective because they guarantee the inflow of products from firms with solid track records. Financing is significantly more problematic if the producer does not have a pact or a deal with a studio, which is the case for a large majority of projects. In that case, the producer will have to obtain initial financing from other sources, a difficult task in particular when no distribution deals are guaranteed (Vogel 2001).

While they pursue different fund-raising options, producers also have to develop the film along other lines: they recruit the director, cast, and crew, scout possible shooting locations, and design sets and costumes, among other things. Talent agents (such as CAA and ICM) play a key role in these activities. At this stage, producers also determine an estimated production budget, based on such factors as the script, likely post-production expenses (e.g. for special effects), star salaries, and financing possibilities. After these activities, which are all part of the 'pre-production' phase, the project enters the actual 'production' phase where the film is shot. This usually lasts a few months. Next, the project enters 'post-production', which consists of activities such as editing, dubbing, creating special effects, and adding music. Before it can be released in a particularly country, the movie also needs to be rated (e.g., by the MPAA in the U.S.).

The above description applies mostly to the movie development process in the U.S. Movies originating in 'Hollywood' dominate box-office rankings across the globe. On average, international theatrical markets now bring in more revenues than the domestic theatrical market. However, of the more than 4,000 movies that are produced worldwide each year, only about 700 are produced in the U.S. (MPAA, 2003; also see Scott 2005). India is the most productive country. Sometimes referred to as 'Bollywood', it produced more than 1,000 films in 2001, which together generated over 45 billion rupees (at the time close to $1 billion) in revenues (U.K. Film Council, 2002). Overseas markets such as the U.K. have become increasingly lucrative for Indian films, sometimes generating nearly a third of total revenues, and allowing for higher production

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budgets. With the notable exception of India, Hollywood products dominate major markets around the world. Even in countries with highly acclaimed local productions, such as France and Italy, non-U.S. movies often represent only a small fraction of box-office grosses (EAO 2003).

Financing the development of a movie is an extremely risky decision rooted in artistic and business considerations. However, we conjecture that:

The Success Rate of the Traditional 'Green-Lighting' Process Can Be Improved

An important puzzle about the motion picture industry is why movies that flop miserably at the box office ever get made. Caves (2001) provides arguments for why such 'ten-ton turkeys' advance through the development process. He explains how, when costs are sunk progressively and information on a project's quality is revealed gradually, rational decision makers can carry projects to completion that realize enormous ex post losses. The movie The Adventures of Pluto Nash, which cost over $100 million to produce but earned less than $5 million in U.S. theaters, is an example of such a type II error. Type I errors, which involve rejecting a potentially successful project, are also a common practice in the industry: a recent example is The Passion of the Christ, the highest-grossing independent movie to date, which was reportedly turned down by several major studios (Quelch et al 2004).

It is because of the 'triggering' effect outlined by Caves (2001) that mistakes in the green-lighting process--the initial decision to approve or decline a project--is very costly. While maximizing the green-lighting success rate (i.e., minimizing the two types of errors) is extremely challenging, it is staggering to discover how little 'science' usually goes into the process. A senior executive at a major studio described the process as follows: "We bring together all studio department heads. Beforehand, our financial department prepares an overview of key estimates to get a sense of the financial viability. It really revolves around the production costs. That is our most reliable estimate, and that thus forms the basis for our launch decision. (...) The idea is to work towards the bottom line. We ask ourselves whether we can recover our production costs, and whether there is room to spend on marketing. In the end, though, it comes down to the fact that someone has to sign off on the deal. Someone in the meeting has to put his or her reputation on the line and say 'yes' ? regardless of whether the numbers add up" (Elberse, 2002).

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